Tuesday, September 16, 2008

The sky isn't falling, but if it were...

As Curt pointed out, despite the sackcloth-and-ash sentiments of the media, yesterday's 500-point market decline does not mean the end is nigh. While yesterday's 500 point decline sounds scary, it represents only 4.4% of the market's value. On 1987's "Black Monday" the market fell 22.6%, or some five times yesterday's decline.

The decline in 1987 was an indicator of a coming recession, but the late 80s recession was more mild than that of the early 80s, and the recession of the late 90s was more mild than its predecessor. Because the economy's underlying weakness stems from one sector -- the housing crisis and bad loans associated with it -- most economists believe this economic slowdown may not even result in recession.

As the Wall Street Journal points out:

Despite the recent turmoil, there is good evidence that the worst is over, especially for the commercial banks with access to Federal Reserve credit. Despite yesterday's severe sell-off, most are significantly higher than their July 15 low, and some such as Wells Fargo and UBS are up over 50%.

And later...

It is easy to be pessimistic about the future of financial services in the current climate. But objective facts indicate that the future demand for these services will be high. Looking beyond past losses, the demand for financial services, especially internationally, has been strong. The growth of the developing countries, combined with the aging in the developed countries, will lead to huge international capital flows that will be facilitated by new and existing financial intermediaries.

It's not all good news. Unemployment will rise. Banks will fail. We'll see a belt-tightening. It's good to be cognizant of these things when making financial decisions.

But, in a strange way, that's a good thing. Our economy continues to grow, year-over-year, decade-after-decade, because we (on the whole) don't prop up bad businesses or keep people employed who wouldn't have a job minus our tax dollars That discipline, that creative-destruction, allows the rest of the economy to get healthy without being dragged down by poor businesses.

There's another good point to the volatility, it creates a tremendous opportunity for wealth. Even during the Great Depression, when it took 25 years for the Dow to return to its Sept. 3, 1929 peak, those who continued to invest regularly, had positive returns after only five years. Or consider the aforementioned drop in 1987. If you had invested every nickel you had at the market's peak of 2,722 in August of that year, watched your portfolio plummet during the October sell-off, but held onto your stocks, even after the dotcom implosion and even after yesterday, you'd be up roughly 5 times your original investment. And, let's be clear, the aforementioned scenario represents a ridiculous and ignorant investing strategy.

The point is, no one can call a bottom, but there are amazing companies out there right now, largely or wholly insulated from the credit crisis, which are selling at a steep discount. They may go lower, but make no mistake, most will go significantly higher.

Let me flog this dead horse a bit longer. If you have $3,000 to invest, and you put $1,000 into three different companies. If you lose 50% on company No. 1, and 50% on company No. 2, and triple company No. 3, despite your losses, you're still up 25%. One last example. If you had invested $10,000 in Apple in 2001 -- with no additional investment -- today it would be worth roughly $180,000 (if you had sold it a few months ago, your investment would be worth roughly $232,000.) If you had continued to invest, say $100 every month, it would be worth exponentially more. For reference, Apple didn't break $15 until 2004.

There are two other bright spots that have been lost amidst the doom and gloom. Gas prices are lower today than they have been since March, inflation declined last month for the first time in a long time, and interest rates remain low. That means, while we are largely unaffected by the market turmoil, we have more money in our pocket today than a month ago.

To paraphrase Shakespeare, Despite the media's penchant for drama, there's nothing either good or bad, but thinking makes it so.

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